Lloyds Banking Group PLC (LYG) 2013 Q2 法說會逐字稿

Thank you for standing by, and welcome to the Lloyds Banking Group 2013 half-year results Fixed Income conference call. At this time, all participants are in a listen-only mode. Charles King and Richard Shrimpton will outline the key highlights of the 2013 Lloyds Banking Group half-year results, which will be followed by a question-and-answer session.

(Operator Instructions)

Please note this call is scheduled for one hour. Please be advised the conference is recorded today, Thursday, August 1, 2013.

I would now like to hand the conference over to Charles King. Please go ahead.

Good afternoon, everyone, and thanks for joining us for the call. I am Charles King. I have been introduced Head of Investor Relations.

I will start with an overview of the strong progress we have made on our strategy and on our financial performance and the guidance we have given in these half-year results; and then I will hand it over to Richard Shrimpton, who is our Group Capital Markets Issuance Director, who will update you on the continued transformation of the balance sheet.

So, in the first half of 2013, we further accelerated the delivery of the strategic plan we set out to you two years ago. The successful execution of our strategy is reflected in the financial performance that we've reported today. Compared to the first half of last year, we delivered a substantial GBP2 billion increase in underlying profit, to almost GBP3 billion, including a one-off gain of GBP433 million from the sale of shares in St. James's Place.

Similarly, statutory profit increased by over GBP2.6 billion, turning a GBP0.5 billion loss in the first half of 2012 into a profit of GBP2.1 billion in the first half of this year. We have seen continued growth in core loans and advances in the second quarter, having returned to growth in the first quarter of 2013; and that was ahead of expectations. This has resulted in GBP3 billion of core loan growth across the half as a whole, and this is after a GBP0.7 billion reduction following the disposal of our core international operations.

On net interest margin, we saw further progress ahead of expectations again, as it rose to 2.01%, driven by substantial reductions in deposit costs and an improved funding mix. We reduced Group costs by 6% as run rate savings from simplification increased to over GBP1.1 billion. Group impairments fell by 43%, and non-core impairments fell by 58%. The significant reductions have primarily been driven by our progress in running off the non-core assets ahead of plan. As a result of all of these dynamics, Group returns increased substantially to 1.95% return on risk-weighted assets and core returns of 3.16% return on risk-weighted assets, and those remain significantly above our cost of equity.

So turning to the outlook for '13. We're on track to meet our existing targets of '13, and we are pleased to be able to upgrade guidance in three key areas. The momentum of the Group is strong, with the growth of core lending set to continue, while Group margin is expected to improve to close to 2.10% for the year. As guided in the first quarter results, we now expect total costs to be around GBP9.6 billion in 2013, and that was GBP200 million lower than previous guidance; and around GBP9.15 billion in 2014, assuming a half year of costs from Verde. We now expect the non-core portfolio to be reduced to less than GBP70 billion by the end of this year, and that's a year ahead of our previous guidance. Within this, we expect there to be less than GBP30 billion of non-retail assets by the end of 2013 and less than GBP20 billion by the end of 2014. Following our full year 2013 results, we will cease separate reporting of the non-core portfolio in line with our previous guidance for a portfolio of this overall size and mix.

Simultaneously, the ongoing prudent management of risk will deliver a substantially lower impairment charge in 2013 as a whole. This combination of accelerated de-risking and the Group's improved financial performance means we are now targeting a fully-loaded core Tier 1 ratio of above 10% by the end of this year, and we will now seek discussions with our regulator regarding the timetable and conditions for dividend payments.

And with that, I'll hand it over to Richard, who will cover capital funding and liquidity in more detail.

Thanks, Charles, and good afternoon everyone.

I'd like this spend the next ten minutes or so updating you on the continued strong progress we have made on the balance sheet. I want to cover funding and capital actions in the first half of 2013 -- how this sits in the face of the continued regulatory change we see, and how the strength of our balance sheet positions us well as we adapt to these rules.

Firstly, starting with funding and liquidity. In the first half of 2013, we grew deposits by GBP8 billion to GBP431 billion and reduced non-core assets by GBP16 billion to GBP83 billion, ahead of plan. As Charles mentioned, we are on track to meet our newly revised targets, and overall this has resulted in our core loans deposit ratio of 100%, whilst for the overall Group, it fell to 117% from 121% at the end of 2012. These positive liquidity flows allow us to execute further debt buybacks in the first half without any material changes to our liquidity buffers.

In total, we canceled around GBP9 billion of wholesale liabilities in addition to the LTRO redemption of GBP11 billion. The overall impact of these actions has seen our primary liquidity remain broadly stable at GBP87 billion, which represents about 2.7 times our Money Market funding and about 1.7 times our wholesale funding with a maturity of less than one year. Secondary liquidity increased by GBP11 billion to GBP128 billion, which means that our total liquid asset portfolio represents over four times our wholesale funding with a maturity of less than one year.

In terms of issuance in the first half, and gross issuance was around GBP2.5 billion, achieved from a combination of privately placed NTMs and capital activities This was significantly offset by maturities and the buybacks I just talked about, resulting in wholesale funding reducing by GBP13 billion in the first half, or by 27% in the last 12 months, to GBP157 billion. Wholesale funding with a maturity of less than one year now stands at 32%, reflecting the lower overall levels of wholesale funding; while short-term wholesale funding remained broadly stable at GBP51 billion].

Over the next 18 months, we are due to see around [GBP30 billion] of term funding mature, pretty much evenly split across our three main term funding channels -- ABS, covered bonds, and senior unsecured, although predominantly skewed to euro and sterling. Overall, there will be little need to refinance this, as it will be largely offset by the continuation of our non-core portfolio reduction.

In that respect, as we look ahead to H2, issuance volumes are expected to be similar to the first half, and I will expect much of this will be achieved from private placements in both covered bonds and medium-term notes. At the same time, we are conscious that during the last few years, we have built up a broad range of funding programs, some of which have not now been used for over two years, and these span across secured and unsecured platforms. Therefore I wouldn't rule out access in these markets in modest size, if appropriate. Overall, we will continue to see further reductions in wholesale funding in 2014, mainly in long-term liabilities, as we are broadly comfortable with our short-term money market balances.

Looking ahead beyond 2014 to what we may call a steady state volume, I'll expect from 2015 onwards that the combination of senior unsecured, public and private, covered bonds and ABS to fuel an annual funding need of around GBP10 billion. Materially, that's [more than] GBP50 billion per issued per annum during 2009 to 2011. Therefore, for funding, and in summary, the combination of a solid deposit base, further reductions in non-core assets, and a reduction in wholesale funding, complemented with a broad range of wholesale funding sources, provides for a great deal of flexibility and optionality when it comes to funding the balance sheet. And that's especially relevant in relation to pricing and access to unsecured markets, which moves us on to capital.

It's obviously been a busy time with regard to capital, and I'll break it down into three areas as I talk through these for the next few minutes. The first area [for us] will be the Group's capital activities that we have undertaken recently. Then I'll look over the UK regulatory aspect, and then broaden this to what is going on in Europe and how the European regulatory changes affect the Group.

We continue to remain confident in our capital position and outlook. Given our strongly capital-generative core business, reductions in RWAs and capital accretive disposals, our fully-loaded core Tier 1 ratio now stands at 9.6%, up 150 basis points from the end of 2012. On current rules, our core Tier 1 ratio improved to 13.7%, and our total capital ratio to 20.4%, already well in excess of the ICB PLAC recommendations.

In terms of leverage ratio, the Group's fully-loaded Tier 1 ratio increased to 4.2% from 3.8% at the end of the 2012; and to 3.5% from 3.1% on a core Tier 1 basis alone. Both of these ratios are well in excess of the Basel Committee's proposed minimum of 3%. Also, as previously announced, we expect to meet the PRA's capital requirements without issuing equity or additional CoCos. We already covered GBP5.1 billion out of the GBP7 billion requirement, and remain confident in meeting this. As Charles mentioned, given the progress we've made in the first half of 2013, we now expect a fully-loaded core Tier 1 ratio of above 10% by the end of 2013, a year ahead of guidance.

Also during the first half, we continued to focus on optimizing the capital structure. In May, we raised GBP1.5 billion of capital from Scottish Widows, which funded a core of low Tier 2 notes issued by Clerical Medical; and the cancellation of internal capital between the Group and Scottish Widows. This contributed to the improved CRD IV total capital position and the Group's rating agency-based equity ratios. In addition to the Clerical Medical core, it was also pleasing in March to be able to call our first eligible Banking Group capital security since 2009, a clear sign of the strong capital position the Group now has.

In addition to the PRA's capital review, we also await the final terms of the Banking Reform Bill, which is currently open to a consultation phase. This bill covers ring fencing and core activities, together with definition around primary loss absorbing capacity, PLAC. In this respect, as I previously mentioned, with total capital well in excess of the 17% suggested, the Group is well-positioned. Finally in the UK, we welcome the recent draft tax legislation surrounding additional Tier 1 securities. We think it's a very positive step forward in understanding how the Bank's capital stack may look like in the future, although it still remains too early to be definitive on the precise components.

Away from the UK and moving into the European landscape -- looking at European regulatory reform on capital, the two main developments are the capital requirements directive and the resolution recovery directive. We are glad to see CRD IV finalized with expected implementation now on January 1, 2014. Like many of you, we are also working through the finer details being proposed by the EBA in their capacity through their Q&A websites and also trying to understand how these will be enforced in due course. We have also seen progress on the resolution and recovery directive, which is expected to be finalized in H2, and among other things focuses on [bailing] and our recently introduced new acronym MREL, which is required minimum eligible liabilities, which is analogous to a total capital leverage ratio. We expect to see the RLD scheduled for implementation between 2016 and 2018.

During the crisis, Lloyds approached capital very conservatively with respect to building our core Tier 1 base. We have also been very deliberate in preserving and strengthening total capital ratios. The introduction of bailing, PLAC, and MREL, places the focus of capital not just at core Tier 1, where the group is now very strong, but also at total capital, which is the overall level of protection in place for senior unsecured creditors and depositors. You'd expect logically that issuers and investors will both want to see this segregation that Lloyds is well positioned for.

As we now move into the transitional phase of CRD IV, there are three primary changes affecting the capital stack. Many of you will be familiar with this, but one, certain eligible items will no longer become eligible, such as deferred tax assets. Two, deductions to total capital will shift in the stack, and predominantly coming from total capital moving into common equity deductions. Finally, there will be a gradual elimination of certain capital securities over this transitional phase. We have already addressed points one and two with our intention to have fully-loaded core Tier 1 above 10% by year end. On the third point, the Group's total capital ratio is now over 20%. With over GBP27 billion of debt to capital only contributing GBP19 billion to the capital base, the transition to CRD IV will reduce the volume of deductions, principally from the Group's insurance operations, and this is expected to release a material proportion of Tier 1 and Tier 2 capital.

This shift is a good thing, in that we have a fairly complicated capital structure. The combinations of legacy issuing entities and liability management has left us with over 130 capital securities, and it would be great to simplify this over coming years. We have no plans do anything right now. If anything, it may be a natural rundown. As I mentioned earlier, we still need to see and understand all of these regulatory changes before doing anything.

In summary, the Group's funding and liquidity positions have transformed beyond recognition since 2009. We have very measured wholesale functioning. We have a well-diversified product, currency, and investor base; and we also have a capital structure that was anticipated and sits well within new capital regulations.

So that concludes what I was planning to say. And I think we'd now like to open this up to questions and answers. So we welcome anything that you may have to ask.

Thank you.

(Operator Instructions)

Your first question comes from the line of Lee [Street] of Morgan Stanley. Please go ahead.

Hello. Good afternoon and thank you very much for holding this call. I appreciate your comments saying that there is lots of uncertainty about total capital ratios and what it might be. Obviously at 20.4%, you look relatively hard, I think there was some suggestion that comes out. Can you give any guidance on what type of ratio in your mind you are thinking about would be the appropriate level to run Lloyds as you look ahead? And you also referenced a natural rundown. Could you define what you mean by a natural rundown? Is that calling? Is that normal amortization? Any color would be very helpful. Thank you.

Yes. Above 20% is high by European standards. I think the European average at the moment is just below 16%. I think we have seen some banks give more specific guidance around future capital stack. We aren't quite there yet. If I could explain a few things here. I mean, we have been, as I say, very deliberate in building total capital ratios. Overall, my and the Group's thoughts have been that it's easier to reduce capital than it is to build it up when you have uncertainty around markets and future capital instruments, and this provides us with a glide path of sorts to transition and as well as the insurance benefits that I mentioned coming through as that deduction switches from debt capital to core Tier 1.

We don't have any specific plans. What we are waiting on is the PRA interpretation of CRD IV. They are due to put a consultation paper out in the near future. What we will also understand as a Group is to understand the relativity of the proportion of total capital you hold relative to the pricing impact to senior unsecured deposits. Overall, we've got plenty of flexibility to manage the capital base. I think in terms of the reductions I talked about, we have coming up over the next couple of years quite a significant amount of maturities from Tier 2 instruments, but also regulatory amortization coming through from bullet Tier 2 securities. And you, like us, are obviously reading the EBA guidance that they are putting out, which is providing more color around the treatment of capital securities. So it may not be necessarily be true calling, but it may be through de-recognition that that capital base will slowly unwind.

That makes sense. One second one, if I may. On the CNs, can you confirm or give a bit of discussion around whether they still qualify as stress test capital for the regulator?

Well, of course. I mean, it depends on the severity of your stress test, but yes, under a severe stress test, they still qualify for stress test capital. Fundamentally, I think with a core Tier 1 ratio as high as it is in the trigger, under an old definition of 5%, it has to be a pretty severe stress. Basically, I think that it fully qualifies through security, and there is currently no expectation they wouldn't qualify under any of the CRD IV criteria.

That is very helpful. Thank you very much for your time.

Thank you. Your next request comes from the line of Robert Smalley of UBS. Please go ahead.

Hi. Good morning, and thanks for doing this call in daylight hours for us in the states, as well. We appreciate it. A couple of quick questions, and I'm referring to the half-year results around in the 90s because I want to talk about subordinated debt a little bit picking up on some of your points and Lee's points. Bottom of the page, on 91.

Yes?

Looking at subordinated liabilities, the total at the half year at GB35.3 billion, up from GBP34.1 million, I guess from your remarks that was primarily from private placements?

No. That increase there will be the Scottish Widows we did in March. There is GBP1.5 billion there which offsets some other capital management activities we did in the first half. Those will be an element of changes through currency adjustments, as well.

Good. And reconciling this GBP35.3 billion to -- and now I'm going over to page 98 -- the GBP17.892 billion.

Yes.

How do I get from here to there?

Sure. Well, basically, you've got, I guess, three aspects. One is the balance sheet number. Then there is the regulatory capital number. And then there is the net capital number. So looking at the balance sheet, if you (inaudible) on slide 91, we have GBP34 billion of subordinated securities, that expands to Tier 1 and Tier 2. Then from a regulatory capital perspective, these securities have a number of adjustments. So, for instance, there will be fair value adjustments in different carrying values that we have these on our books that ultimately feed through to the amount that contributes to regulatory capital. That number there is GBP27 billion of regulatory capital. So GBP34 billion reduces to GBP27 billion with these various adjustments that go into your hybrid debt Tier 1 and Tier 2 buckets. That number has been further reduced from GBP27 billion due predominantly to the GBP11 billion of supervisory deductions we have stemming from our insurance businesses. Sorry, not the GBP11 billion, now it's changed. It's a little bit less than that. It changes. The deductions coming through our insurance businesses reflects both the debt and the equity between Lloyds Banking Group and Scottish Widows.

Right. So that's what gets us to the GBP17.9 billon?

Yes.

Okay. And --

My point is that the insurance deduction will gradually shift towards equity during the transition period of CRD IV.

And that's what you are referring to on 102 as well in the comments, I guess?

Yes. The deduction, which is something like that. It's just (inaudible).

Picking up on Lee's point, in terms of leaving lower Tier 2 securities outstanding, potentially as junior funding if they have low coupons. I know you mentioned the term, and this is something we have discussed, a simplification exercise. Could you speak to the philosophy behind the idea of leaving lower Tier 2 securities that may not qualify as capital outstanding as funding? Does that -- where does that stand versus trying to simplify the right side of your balance sheet?

Very fair question. I think there is a couple things here. We've obviously got a strong capital position. We have in the first half, as I mentioned, we have called a couple capital securities, which is the first capital securities we have called since 2009. But that obviously -- and you get this -- we can't tell you what we're going to do on capital securities in the future. I think, very much, that the guidance I would stage at the moment is a case by case approach.

To your question, what are going to be the determinants of how we value calling or not calling capital securities and whether they would ultimately contribute to regulatory capital or, as you say, a junior form, will be, I guess, steered around finally understanding what the EPA proposals are stemming from CRD IV, and then ultimately how the PRA will interpret this, and how they will implement the CRD IV package with regards to capital instruments. And then we need to, I guess, understand what the debt from the cost is of new instruments, and look at bonds on a case-by-case basis with regard to the back end cost versus the alternatives. And then overlay that with things like PLAC and MREL and try to understand what the value is of holding anything like that. So there's a lot of factors that influence how we look at core policy in the future and how we treat these securities. But, it is still a bit too early to actually give too much guidance on how we would approach these. Suffice to say what we've tried to do over the last three or four years despite on many occasions our hands being relatively tied is to do the right thing.

Thank you. Your next question comes from the line of James Hyde of Pramerica.

My questions relate more to Scottish Widows and any further dividend upstreaming. I was wondering, I mean, you have given the ITD surplus in billions. But I was wondering, can you tell us about where you would be in terms of how comfortable each of the rating agencies are with the level of capital? I mean, for instance, S&P has a negative outlook on the whole Lloyds Group. Is there anything you can do with capital to, -- at the level of Scottish Widows to prevent them downgrading? And in general, are the current tenders at Scottish Widows, do they change your assumptions of how much you are going to be dividending up?

Sure. Some of these questions we may need to take offline. But I think primarily, Scottish Widows is a separately run business with its own board and regulatory oversights. It does, however, consider the upstreaming of dividends on a regular basis as part of its ordinary course of business. I think that, what we as a Group, we are very cognizant of rating agencies, and we work closely with the rating agencies in understanding any aspect of our business, how that may impact the rating agency reaction, and have borne that into our thinking on several occasions over the past few years. We obviously can't comment about future dividend payments, and Scottish Widows report on an annual basis, not a semi-annual basis. I can't give you too many specific updates in terms of the performance in the current surplus sitting within the insurance division. As Antonio mentioned on the equity call this morning, we do look at it and ensure that there is a prudent level of capital in that company to ensure it satisfies a number of stakeholders, and obviously, one of those stakeholders is rating agency management.

Thanks.

Thank you.

(Operator Instructions)

You now have a question from the line of Gildas Surry of Citi. Please go ahead.

Thank you very much. Following up on your answer to lease questions on the tradition to add new formats of capital, can you comment on your approach on the optionality you have in the valuation and distribution of some Tier 1s? I am thinking of your (inaudible) where you can reduce the coupon and make the Tier 1 security, Tier 2 a little [bit] regarding to the terms and conditions of the bond? Thank you.

Sure. It's a really bad line. But if I heard -- understood you correctly, you are saying are there any Tier 1 securities where we could modify the terms to make them manageable as a Tier 2?

And the coupons stepdown [long] grade, and that still is under the substitution and valuation clauses.

Yes. I mean, obviously some of our bonds include elements such as substitutions of variation. I mean, it falls into the camp of we are still waiting to see the answers coming from the EBA and then understanding how the PRA will interpret. Obviously, something like that is one of the options that we have. It doesn't extend to many bonds, if I recall rightly. Yes, there is a handful of Tier 1 securities that have do substitution variation clauses as long as it's not detrimental to investors in there, and we obviously need to take note of that.

Thank you very much.

Thank you.

(Operator Instructions)

As there are no further questions at this time, that does conclude our conference for today. If you have any further questions, please e-mail or telephone Investor Relations. For those of you wishing to review this conference, the replay facility may be accessed by dialing, within the UK on 0800-953-1533. The US on 1-866-247-4222. Or, alternatively, on the standard international on 00441452550000. The reservation number is 21090368. Thank you for participating. You may all disconnect.